Inflation Report 2/2004 Norges Bank’S Inflation Report
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Reports from the Central Bank of Norway No 3/2004 11 Inflation report 2 with monetary policy assessments 04 J u l y Inflation report 2/2004 Norges Bank’s Inflation Report Norges Bank’s Inflation Report is published three times a year, in February/March, June/July and October/November.Sections 1-4 of the report contain an analysis of developments in inflation, output and demand 3 years ahead. As from Inflation Report 2/04, the Executive Board’s monetary policy strategy and interest rate setting will be published in Section 5 of the Inflation Report. 2 The Inflation Report is published three times a year, and together with Financial Stability, is part of Norges Bank’s series of reports. The report is also available on Norges Bank’s website: http://www.norges-bank.no. The series of reports is included in the subscription for Economic Bulletin. To subscribe please write to: Norges Bank Subscription Service PO Box 1179 Sentrum N-0107 Oslo Norway Telephone: +47 22 31 63 83 Fax: + 47 22 41 31 05 E-mail: [email protected] Editor: Svein Gjedrem (Section 5 presents the Executive Board's assessments) Design: Grid Strategisk Design AS Setting and printing: Reclamo grafisk senter AS The text is set in 111⁄2 point Times ISSN 0807-8521 Inflation report 2/2004 Monetary policy in Norway Objective The Government has defined an inflation target for monetary policy in Norway. Norges Bank’s operational conduct of monetary policy shall be oriented towards low and stable inflation. The operational target of monetary policy shall be annual consumer price inflation of approximately 2.5 per cent over time. In general, direct effects on consumer prices resulting from changes in interest rates, taxes, excise duties and extraordinary temporary disturbances shall not be taken into account. Norges Bank places particular emphasis on CPI inflation adjusted for tax changes and excluding energy products (CPI- ATE) when assessing underlying inflation. Horizon and implementation 33 Norges Bank operates a flexible inflation targeting regime, so that weight is given to both variability in inflation and variability in output and employment. Monetary policy influences the economy with long and variable lags. Norges Bank sets the interest rate with a view to stabilising inflation at the target within a reasonable time horizon, normally 1-3 years. The more precise horizon will depend on disturbances to which the economy is exposed, and how they will affect the path for inflation and the real economy ahead. The decision-making process The key interest rate is set by Norges Bank’s Executive Board. Decisions concerning interest rates and other important changes in the use of instruments will normally be taken at the Executive Board’s monetary policy meeting every sixth week. The analyses in Norges Bank’s Inflation Report, together with assessments of price and cost developments and conditions in the money and foreign exchange markets, form the basis for monetary policy decisions. The main features of the analysis in the Inflation Report are presented to the Executive Board for discussion at a meeting about two weeks before the Report is published. On the basis of the analysis and discussion, the Executive Board assesses the consequences for the monetary policy strategy and interest rate-setting in the period to the next Inflation Report. Their assessments are published in Section 5 of the Inflation Report. Communication of the interest rate decision and reporting The monetary policy decision is announced at 2pm on the day of the meeting. The Bank holds a press conference at 2.45pm on the same day, whether interest rates are changed or left unchanged. The press release and the press conference are available on Norges Bank’s website, www.norges-bank.no. Norges Bank reports on the conduct of monetary policy in the Inflation Report and the Annual Report. The Bank’s reporting obligation is set out in §75c of the Constitution, which stipulates that the Storting shall supervise Norway’s monetary system, and in §3 of the Norges Bank Act. The Annual Report is submitted to the Ministry of Finance and communicated to the King in Council and to the Storting in the Government’s Kredittmelding (Credit Report). The Governor of Norges Bank provides an assessment of monetary policy in an open hearing before the Standing Committee on Finance and Economic Affairs in connection with the Storting deliberation on the Credit Report. Inflation report 2/2004 4 Inflation report 2/2004 Inflation Report 2/2004 with monetary policy assessments Editorial 7 Summary of economic developments 8 1. Recent developments 10 2. International developments 16 3. Domestic developments 20 5 4. Inflation projections 27 5. Monetary policy assessments and strategy 34 Boxes Recent price developments 14 Increase in number of working days in 2004 21 Financial stability 43 Norges Bank's estimate of the output gap 46 A change in inflation expectations? 49 Preliminary evaluation of the projections in Inflation Report 1/04 51 What are the factors behind the rise in oil futures prices? 55 Annex Regional network 59 Statistics 65 Detailed projections and assumptions 71 The cut-off date for the Inflation Report was 1 July 2004 Sections 1 - 4 are based on information in the period to 24 June Inflation report 2/2004 6 Inflation report 2/2004 Editorial Continued need for low interest rates Pursuant to §3 of the Norges Bank Act, Norges Bank shall inform the public about the assessments underlying decisions relating to the conduct of monetary policy. The transparency of the basis for monetary policy decisions has increased substantially in recent years.1 Norges Bank is now further enhancing transparency by publishing the Executive Board's monetary policy strategy for the next four months (Strategy Document) as part of the Inflation Report at the beginning of the period. Since we for a period have also presented a more extensive account of the background for interest rates decisions, it will no longer be necessary to publish a separate statement with an assessment of the inflation outlook. The formulations as to the horizon for monetary policy have also been adjusted. The new wording reads as follows: Monetary policy influences the economy with long and variable lags. Norges Bank sets the interest rate with a view to stabilising inflation at the target within a reasonable time horizon, normally 1-3 years. The more precise horizon will depend on disturbances to which the economy is exposed and how they will affect the path for inflation and the 7 real economy ahead. The new formulations better express the conduct of monetary policy. The point of departure for the monetary policy strategy ahead is the very low level of inflation. Inflation has been lower than the inflation target since autumn 2002. The aim of monetary policy is higher inflation. The monetary policy stance is therefore expansionary. The projections in this report are based on the assumption that the interest rate and krone exchange rate move in line with market expectations. There is considerable uncertainty surrounding these assumptions, and hence price developments. In relation to the previous Inflation Report in March, where inflation was projected to return to target two years ahead, the projections are now based on the assumption that the krone exchange rate will be 31⁄2% stronger through the projection period. This is the main reason why the projections in this report show a path for inflation where inflation does not reach target until summer 2007. The Executive Board's assessment is that monetary policy should be oriented towards achieving higher inflation at an earlier stage. A more expansionary monetary policy than in the baseline scenario in this report might contribute to this. The most appropriate alternative now seems to be that the interest rate should be kept unchanged for a longer period than indicated by market expectations. The prospect of continued low inflation in Norway also implies that Norway should not be the frontrunner when interest rates are increased in other countries. The Executive Board’s assessment is that the economic projections imply a sight deposit rate in the interval 11⁄4 - 21⁄4% at the beginning of November 2004. If the krone appreciates substantially, this may provide a basis for considering an interest rate at the lower end of, or below, the interval. The unusually low interest rate and uncertainty concerning the effects of previous monetary policy easing imply that we should exercise caution with regard to further interest rate reductions. On the other hand, given the prospect of low inflation ahead, wide deviations from projected economic developments would be required before it would be appropriate to increase the interest rate within the strategy period. Jarle Bergo 1 July 2004 1 See box on page 21 in Norges Bank's Annual Report for 2003. Inflation report 2/2004 Summary of economic developments Inflation is low. Since the March Inflation Report, inflation has moved in line with projections. Inflation is being restrained by the appreciation of the krone in 2002, the fall in prices for imported consumer goods, measured in foreign currency, and strong competition in many industries in Norway. Low interest rates and the international upturn are stimulating activity in the Norwegian economy. According to preliminary national accounts figures, demand in the mainland economy was stronger than projected at the end of last year and early in 2004. The output gap is expected to close, but to remain marginally negative in 2004. 8 The cyclical upturn in the world economy has gained a firmer footing. The recovery is broadening, particularly reflecting a pick-up in growth in several euro-area countries in recent months. Growth among Norway’s main trading partners has been somewhat stronger than previously assumed, and growth projections for 2004 have been revised upwards.